DEVELOPMENT
ECONOMICS
From the Poverty to the Wealth of Nations
Third Edition
Y U J I R O HAYAMI
Y O S H I H I S A G O D O
OXPORD
UNIVERSITY PRESS
Great Clarendon Street, Oxford 0X2 6DP
Oxford University Press is a department of the University of Oxford. It furthers the University's objective of excellence in research, scholarship, and education by publishing worldwide in
Oxford New York
Auckland Bangkok Buenos Aires Cape Town Chennai Dar es Salaam Delhi Hong Kong Istanbul Karachi Kolkata Kuala Lumpur Madrid Melbourne Mexico City Mumbai Nairobi Sao Paulo Shanghai Taipei Tokyo Toronto
Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries
Published in the United States
by Oxford University Press Inc., New York © Yujiro Hayami and Yoshihisa Godo, 2005 The moral rights of the author have been asserted Database right Oxford University Press (maker) First published 2005
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press,
or as expressly permitted by law, or under terms agreed with the appropriate reprographics rights organization. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above
You must not circulate this book in any other binding or cover and you must impose this same condition on any acquirer British Library Cataloguing in Publication Data
Data available
Library of Congress Cataloging in Publication Data Data available
ISBN 0-19-927270-0 (hbk.) ISBN 0-19-927271-9 (pbk.) 1 3 5 7 9 1 0 8 6 4 2
Typeset by Newgen Imaging Systems (P) Ltd., Chennai, India. Printed in Great Britain
on acid-free paper by
Preface to the Third Edition
The first edition in 1997 of this book, single authored by Yujiro Hayami, was a translation (with revisions) from a Japanese version under the title Kaihatsu
Keizaigaku published by the Sobunsha Publishing Company in Tokyo in
1995, which was later translated into Chinese and published by the Social Science Documents Publishing House in Beijing. The second edition in 2001 was also first published in Japanese in 2000. In contrast, this edition jointly authored by Yujiro Hayami and Yoshihisa Godo was prepared in English for an international audience from the beginning.
This edition aims to render a perspective on the problems in developing economies in the new millennium. For this goal, most data are updated to 2000 or more recent years wherever possible, while the previous edition used 1995 as the baseline for data comparisons across countries. In particular, Chapter 2 is completely restructured with the new data set.
During the decade centring in 2000, a major change occurred in the current of development thought. At the time the second edition was prepared, international development assistance policies were still dominated by the voice of economists in the International Monetary Fund, the World Bank and the US Department of Treasury advocating the use of free markets for the development of developing economies—the so-called 'Washington Consensus.' In the less than ten years which followed, however, this view was largely replaced by the so-called 'Post-Washington Consensus' advocating greater roles for the public sector and civil society in reducing poverty. This process was outlined in Chapter 8 (Sections 8.5 and 8.6). A major factor underlying this paradigm change was the rising emphasis on poverty reduc-tion as the direct objective of development policies, as epitomized by the United Nations' Millennium Development Goals. In the previous edition, issues concerning poverty were discussed in Chapter 7 as a part of the problem of income distribution. In this edition, however, the measurement and ana-lysis of poverty in relation to economic development are treated more squarely, with the title of Chapter 7 changed from 'Income Distribution and Environmental Problems' to 'Income Distribution, Poverty, and Environ-mental Problems.'
Further, in response to comments from several instructors and students who used the previous edition as a text, two appendices are added: (B) on the Pigou theorem of equivalence between tax and subsidy in removing negative externality and (C) on the theory of agricultural land tenure choice.
The preparation of this edition was supported by the Foundation for Advanced Studies on International Development (FASID), Tokyo. We would like to express sincere appreciation for both financial/logistic support from the FASID administration and academic input from the members of the FASID graduate faculty including Keijiro Otsuka, Tetsushi Sonobe, Kaliappa Kalirajan, Debin Ma, Kei Kajisa, Takashi Yamano, and Futoshi Yamauchi. Also invaluable were the comments on the previous editions as well as on new materials that were received from Robert Allen, Masahiko Aoki, Kenneth Arrrow, Randolph Barker, Kaushik Basu, Abdul Bayes, Partha Dasgupta, Robert Evenson, Avner Greif, Shigeki Hakamada, Koichi Hamada, Robert Herdt, Mahabub Hossain, Hall Hill, Takashi Inoguchi, Takenori Inoki, Shigeru Ishikawa, Bruce Johnston, Michael Kevane, Masao Kikuchi, Taejong Kim, Hirohisa Kohama, Ryutaro Komiya, Takashi Kurosaki, Laurence J. Lau, Justin Lin, Masahiro Matsushita, Ryosin Minami, Watsuji Nakagane, Takashi Negishi, Douglas North, Masahiro Okuno-Fujiwara, Elinor Ostrom, Jean-Philippe Platteau, Agnes Quisumbing, Gustav Ranis, Vernon Ruttan, Yasuyuki Sawada, T. N. Srinivasan, Paul Streeten, Akira Suehiro, Juro Teranishi, Erik Thorbecke, Henry Wan, Jr., and Yasukichi Yasuba. Technical assistance from Suzanne Akiyama and Yue Yaguchi is gratefully acknowledged.
The biggest impact on us that may have made this edition distinct from the previous edition has come from the students in the graduate programme on international development studies organized jointly by FASID and the National Graduate Institute of Policy Studies (GRIPS). As our students are mainly sent from development agencies (including NGOs) in Africa and Asia as well as Japan, their motivation for mastering development economics is extremely high. Intensive interactions with them for the past four years have constantly forced us to try to make this volume a truly useful guide for the design of development policies for their nations in the future. In gratitude for the stimulus received from them, this edition is dedicated to the students, both present and past, in the FASID-GRIPS joint graduate programme.
Yujiro Hayami and Yoshihisa Godo April 2004
Contents
Detailed Contents viii List of Figures xv List of Tables xvii
Introduction 1 1. A Theoretical Framework for Economic Development 9 2. A Comparative Perspective on Developing Economies 31 3. Population Growth and the Constraint of Natural Resources 63 4. Breaking the Natural Resource Constraint 92 5. Capital Accumulation in Economic Development 122 6. Patterns and Sources of Technological Progress 161 7. Income Distribution, Poverty, and Environmental Problems 191 8. Market and State 242 9. The Role of Community in Economic Development 310 10. Tradition and Modernization: A Concluding Remark 349
Appendices 362 Bibliography 383 Index of Names 415 Index of Subjects 421
List of Figures List of Tables
Introduction
Scope of development economics Organization of the book
1. A Theoretical Framework for Economic Development 1.1 Development of the Social System
1.1.1 A model of dialectic social development 1.1.2 A historical example
1.1.3 Marx and new institutionalism 1.2 The Theory of Induced Innovation*
1.2.1 Induced technological innovation 1.2.2 Induced institutional innovation 1.2.3 Logic of political market 1.2.4 Historical path dependency
1.3 Developing Economies in the Light of the Theoretical Framework
2. A Comparative Perspective on Developing Economies 2.1 Economic Growth and Structural Change
2.1.1 Per capita GDP and its growth 2.1.2 Changes in industrial structure 2.2 Sructure of Capital Accumulation
2.2.1 Capital formation and savings in economic growth 2.2.2 External debt and inflation
2.3 Accumulation of Human Capital 2.3.1 Measurement of human capital
2.3.2 Human capital investment and economic growth 2.4 Population, Natural Resources, and Foods
2.4.1 Population pressure on natural resources 2.4.2 Population growth vs. food supply
* General readers not interested in technical detail may wish to skip sections marked with an asterisk (*) xv xvii 1 2 5 9 9 9 12 14 16 16 20 21 25 27 31 32 32 37 42 43 45 49 50 51 54 54 56
Detailed Contents ix 3. Population Growth and the Constraint of Natural Resources
3.1 Population Growth in Economic Development 3.1.1 Historical changes in world population 3.1.2 Demographic transition
3.1.3 The case of India
3.2 Economic Theories of Population Growth 3.2.1 The Malthus model
3.2.2 The household utility maximization model*
3.3 Theories of Resource Constraint on Economic Growth 3.3.1 From Malthus to the Club of Rome
3.3.2 The Ricardo model* 3.3.3 The dual economy model*
4. Breaking the Natural Resource Constraint
4.1 Potential of Science-Based Agriculture 4.2 A Perspective on the Green Revolution
4.2.1 Development and diffusion of modern varieties 4.2.2 Conditions of technology transfer
4.2.3 External and internal land augmentation 4.3 Barriers to Induced Innovation
4.3.1 Problems in Africa
4.3.2 Whither the Green Revolution? 4.4 Development via Natural Resource Slack
4.4.1 Colonialism and the vent-for-surplus theory 4.4.2 The staple theory
4.4.3 The Dutch disease
5. Capital Accumulation in Economic Development
5.1 From Adam Smith to Marx 5.1.1 Capital in Adam Smith
5.1.2 Ricardo revisited
5.1.3 The Marx model of capitalist development* 5.1.4 The Marx model and the efficiency wage theory* 5.2 Development Theories and Policies after World War II
5.2.1 The theory of balanced growth
5.2.2 Application of the Harrod-Domar model* 5.2.3 The model of low-equilibrium trap* 5.2.4 Development theories and policy choice
63 63 64 67 70 73 73 74 78 78 80 85 92 92 96 97 99 104 107 109 111 115 116 117 119 122 123 123 125 126 131 133 134 135 136 138
5.3 Neoclassical Production Function and Growth Model 5.3.1 Different assumptions of the production function 5.3.2 The Solow-Swan model*
5.4 Growth Accounting Test
5.4.1 The growth-accounting equation 5.4.2 Sources of modern economic growth 5.5 Changes in the Pattern of Economic Growth
5.5.1 A historical extension of growth-accounting 5.5.2 A trap in the Marx-type growth
6. Patterns and Sources of Technological Progress
6.1 The Marx vs. the Kuznets Pattern of Economic Growth 6.1.1 Stylization of the two patterns
6.1.2 Trends in the rates of saving, interest, and wages 6.2 Technological Conditions of the Two Growth Patterns
6.2.1 The shift in the industrial technology regime 6.2.2 The shift in the demand structure
6.2.3 Borrowed technology and the Marx-type growth 6.3 Searching for the Sources of Technological Progress
6.3.1 Accounting for TFP growth* 6.3.2 Schooling and economic growth
6.3.3 Increasing returns and the endogenous growth model* 6.3.4 Schumpeter and centrally planned economies 6.3.5 Institutional conditions of borrowing technology
7. Income Distribution, Poverty, and Environmental Problems
7.1 Inequality and Poverty
7.1.1 Concepts and measurement of income distribution 7.1.2 Concepts and measurement of poverty
7.1.3 Patterns of changes in inequality and poverty
7.2 Causes of Inequality
7.2.1 Changes in factor shares 7.2.2 The dual economic structure
7.2.3 Agriculture-non-agriculture income differential 7.2.4 On the redistribution of incomes and assets 7.3 Economic Stagnation and Poverty
7.3.1 Income distribution effects of the Green Revolution 7.3.2 A comparison of two villages in Indonesia
139 139 141 145 145 148 151 152 155 161 161 162 164 168 168 169 171 173 173 176 181 184 188 191 191 191 195 198 209 209 210 211 213 216 217 220
Detailed Contents xi
7.4 Environmental Problems in Economic Development 7.4.1 The core of environmental problems
7.4.2 Rural poverty and environmental destruction
7.4.3 Industrialization and environmental pollution 7.4.4 Lowering the peak of the inverted-U-shape curve 7.4.5 Towards global coordination
8. Market and State
8.1 The Economic Functions of the Market and the State 8.1.1 Efficiency of the competitive market
8.1.2 Market failure 8.1.3 Government failure
8.1.4 On the choice of economic system
8.2 Around the Infant Industry Protection Argument 8.2.1 Market failure in dynamic economy
8.2.2 Ricardo vs. List 8.2.3 The Listian trap
8.2.4 The import-substitution industrialization policy 8.3 The Rise and Fall of Developmentalist Models
8.3.1 The limit of information and the role of ideology 8.3.2 Defeat of the old developmental market economies 8.3.3 Collapse of the centrally planned economies 8.3.4 Trap of populism
8.4 Success and Failure of the New Developmental Market Economies
8.4.1 The system of new developmental market economies 8.4.2 The source of success
8.4.3 Beyond achieving the catch-up goal
8.5 Resurgence of Market Liberalism and its Consequences 8.5.1 The structural adjustment policy of the IMF and
the World Bank
8.5.2 Recurrent crises in Latin America 8.5.3 Financial crisis in East Asia
8.6 From the Washington Consensus to the Post-Washington Consensus
8.6.1 Criticisms of the Washington Consensus 8.6.2 Poverty reduction as an immediate objective 8.6.3 The post-Washington Consensus prospect
223 224 226 228 232 235 242 242 244 245 247 249 250 251 252 253 254 257 258 259 263 265 268 268 270 277 280 280 282 288 295 295 298 303
9. The Role of Community in Economic Development 9.1 The Economic Functions of Community
9.1.1 Prisoner's dilemma 9.1.2 Trust as a social capital 9.1.3 Supply of local public goods
9.2 Rural Organization in Developing Economies 9.2.1 Dominance of peasants
9.2.2 Management of common-property resources 9.2.3 Landlord-tenant relations
9.3 Economic Rationality in Community: A Perspective from Philippine Villages
9.3.1 Labour hiring by peasants 9.3.2 Income and work-sharing 9.3.3 Changes in the sharing system 9.3.4 The role of community norm 9.3.5 Egoism and altruism
9.4 The Community in Market Development 9.4.1 Ethnic networks and guilds
9.4.2 From the putting-out to the modern
subcontracting system
9.4.3 Overcoming the community failure
9.5 Towards an Optimal Combination of the Community, the Market, and the State
10. Tradition and Modernization: A Concluding Remark 10.1 Institutional Innovation for Technology Borrowing 10.2 The Experience of Japan
10.3 Multiple Paths to Economic Modernization
Appendix A: Theoretical Supplements to Technological Progress A. 1 Increases in the capital-labour ratio and shifts in
production function
A.2 The classification of technological change A.3 Changes in the trends of factor prices and
factor shares
A.4 Possibilities for induced innovation
A.5 Interpretation by the meta-production function A.6 Mathematical analysis of changes in factor shares Appendix B: The Pigou Theorem on Equivalence between Tax and Subsidy in Removing Externality
310 311 312 313 316 317 317 321 324 328 329 331 332 335 338 339 340 341 343 346 349 349 351 355 362 362 363 367 368 370 372 374
Detailed Contents xiii Appendix C: Theories on the Choice of Land Tenure System
Bibliography Index of Names Index of Subjects 378 383 415 421
List of Figures
1.1 Interrelated developments in the social system 10 1.2 A model of induced innovation 18 1.3 A model of political market for a public good 23 2.1 International comparison between per capita GDPs in current US dollars
converted by exchange rate and purchasing power parity, 2000 35 2.2 International comparison of the average annual growth rates of
GDP (converted by exchange rate, 1965-2000 averages) and
ratio of capital formation to GDP (1965-2000 averages) 45 2.3 Changes in GDP per capita and I-S gap from the 1965-80
averages to the 1981-2000 averages 46 2.4 International comparison of the average number of years
of schooling and average life expectancies at birth, 2000 52 2.5 International comparison of the average annual growth rates
of per capita GDP from 1965 to 2000: and (a) increases in the average number of years of schooling from 1965 to
2000; (b) the average life expectancies at birth from 1965 to 2000 53 2.6 International comparison of the average annual growth rates of
per capita GDP from 1965 to 2000 and percentage increases in
food production per capita from 1965 to 2000 57 3.1 Changes in the birth- and death-rates in the UK, 1750-1970,
nine-year moving averages 68 3.2 Changes in the birth- and death-rates in India, 1901-2000,
ten-year averages 71 3.3 The Malthusian population theory and its revision 74 3.4 A household utility maximization model on the determination of
the number of children 75 3.5 The Ricardo model of economic development 83 3.6 The dual economy model of the Lewis-Ranis-Fei type 87 4.1 Long-term changes in real prices (deflated by 1967-standard CPI)
and yield per hectare of corn and wheat in the USA 95 4.2 Increases in paddy yield per hectare corresponding to diffusion
of the modern varieties with different characteristics of
resistance to brown planthopper Biotypes I and II 99 4.3 Changes in rice yield per hectare (in brown rice) in Japan,
Taiwan, and Korea, five-year moving averages, semi-log scale 101 4.4 Changes in farmland area per worker, percentages in area
improved by land infrastructure development projects, and
4.5 Relationship between marginal costs of agricultural production from new land openings and from irrigation construction 4.6 Paddy yields per hectare harvested in selected Asian countries,
1953-2000, five-year moving averages
4.7 Rice price and public investment in irrigation, Philippines and Sri Lanka, 1960-98
5.1 The Marx model of capitalist economic development 5.2 The model of low-equilibrium trap
5.3 Comparison between the Solow-Swan model and the Harrod-Domar model
6.1 Movements in the ratios of domestic saving to GDP and
national saving to GNI in Japan, 1883-2001, five-year
moving averages
6.2 Movements in the real rate of interest in Japan, 1882-2002 6.3 Movements in the real wage rate in Japan (1934-36 = 100),
1886-2002, seven-year averages, semi-log scale
6.4. The Japan/USA and Korea/USA ratios in average schooling, per capita GDP, and capital-labour ratio
7.1 Lorenz curves for Bangladesh, Brazil, and Japan 7.2 International comparison of the Gini coefficients 7.3 International comparison of absolute poverty
7.4 GDP growth and poverty indexes in Thailand, 1962-2001 7.5 Cumulative percentage of farms in three size classes adopting
modern varieties and tractors in thirty villages in Asia 7.6 International comparison of carbon dioxide emission 9.1 The pay-off matrix of the prisoner's dilemma game A. 1 Elements of growth in labour productivity
A.2 Classifications of technological progress and substitution between labour and capital
A.3 Income shares of labour and capital
A.4 Possibilities for induced technological innovation A. 5 Factor substitution along meta-production function
B.1 The Pigou model on the equivalence between tax and subsidy in achieving social optimality under externality
C.1 Model of land tenancy
105 112 115 127 137 143 165 166 167 178 194 201 205 208 219 229 312 363 364 366 369 371 374 379
List of Tables
2.1 Major development indicators in selected economies 2.2 Changes in the sectoral shares of GDP in selected economies 2.3 Changes in the structure of merchandise export and the
competitive performance of industry in selected economies 2.4 Investment, saving, external debt, and inflation in
selected economies
2.5 Improvements in education and health in selected economies 2.6 Population, land, and food production in selected economies 3.1 World population, 1000-2050
3.2 Population in India, 1871-2001
5.1 Growth rates of output, input, and productivity in selected developed countries
5.2 Accounting for long-term growth in labour productivity in the USA and Japan
5.3 Accounting for growth in labour productivity in the former Soviet Union
5.4 Comparisons in the growth rates of labour productivity and TFP between newly industrializing economies (NIEs) and developed industrial economies
6.1 Stylized facts in the two phases of modern economic growth 6.2 Sources of growth in national income per person employed in
selected developed economies
7.1 Cumulative shares of household incomes, by quintile class of households, Bangladesh, Brazil, and Japan 7.2 Estimates of the Gini coefficient in Japan, 1890-1998
7.3 Estimates of regression equations to explain the Gini coefficients 7.4 Estimates of regression equations to explain absolute poverty 7.5 Historical changes in agriculture-manufacturing relative
labour productivity, agriculture-industry terms of trade, farm-non-farm household relative income in Japan, 1885-2000 7.6 Mexican wheat acreage as percentage of all wheat acreage by
size and tenure of holdings: 1969-70 post-monsoon season in Lyallpur, Sahiwal, and Sheikhupura districts, Pakistan 7.7 Economic changes in a survey village in Indonesia in which
modern rice varieties failed to be adopted, 1968-71 to 1978 7.8 Economic changes in a survey village in Indonesia in which
modern varieties of rice were successfully adopted, 1968-71 to 1978 7.9 Estimates of regression equations to explain carbon dioxide emission
33 39 40 44 51 55 65 71 150 152 155 157 162 174 194 200 202 207 212 218 221 222 230
9.1 Labour inputs per hectare of rice crop area in Japan, Philippines, and Indonesia
9.2 Comparisons between the actual revenue of harvesters and the imputed cost of harvesting labour under the hunusan and the gama contracts in a survey village (Village E) in the Philippines, 1976 wet season
9.3 The cost-return structures of rice production, estates vs. peasants in Village W, Philippines, 1977 dry season
C. 1 Orders of magnitudes in risk, contract enforcement cost and enterpreneurial opportunity associated with alternative contracts
330
334 337 381
Introduction
The world today is characterized by extremely large income inequality among countries. According to the World Bank's World Bank Indicators 2003, average per capita income in 2000 ranged from the level exceeding US$ 25,000 in high-income countries belonging to the Organization for Economic Cooperation and Development (OECD), to the meagre level of only US$ 280 among the least developed countries (39 countries in Sub-Saharan Africa according to the United Nations' definition).
In that year, the total population amounted to 6.1 billion, of which the population in high-income countries with per capita income above US$ 9,200 numbered only 950 million. Yet this 16 per cent of the global population received more than 80 per cent of world income. In contrast, 2.5 billion people, or nearly 40 per cent of world population, in low-income countries with per capita income below US$ 750 were entitled to only about 3 per cent of the world income.
These per capita income comparisons are made in terms of the United Nations' estimates of gross national income (GNI) converted to US dollars using the official exchange rates. Such comparisons tend to underestimate the level of economic welfare being enjoyed by people in low-income relative to those of high-income economies because of differences between exchange rates and purchasing power parities, as well as incomplete enumeration of non-market goods and services in GNI statistics. Yet, even after this statistical bias is corrected, it is certain that an extremely wide gap in the levels of real income and living remains between low-income and high-income countries, though the gap might be reduced from an order of one to a hundred to an order of one to several tens.
In addition, there are many indicators other than national income statistics to show poverty and destitution in low-income economies. For example, the United Nations' Food and Agriculture Organization (FAO) estimates that chronically undernourished people in 1997-99 amounted to 815 million or about quarter of population in low-income countries, as high as one-third in Sub-Saharan Africa. Another indication is the high infant mortality rate, with as many as 105 out of 1,000 newly born babies dying before reaching age 1 in Sub-Saharan Africa in 2001, in contrast to only 5 in high-income OECD countries.
The escape from such destitution and misery through economic develop-ment must be the common national goal of low-income countries. Indeed,
developing countries that achieved independence after World War II have almost unanimously undertaken ambitious development programmes aimed at catching up with high-income economies. Several success stories have been recorded. Especially remarkable are the so-called 'Newly Industrialized Economies' (NIEs) in Asia, such as Korea, Taiwan, Hong Kong, and Singapore. Starting the early post-World War II period with per capita income levels not much different from those of low-income countries today, these NIEs have now joined the ranks of high-income economies. Following the NIEs, several economies in East Asia, including China, Malaysia, Thailand, and Vietnam have been growing much faster than high-income countries. However, the rates of growth in low-income economies, especially in Sub-Saharan Africa, have been lower than in high-income economies, with the result being widening worldwide differentials in per capita income.
It should not be difficult to imagine how such growing inequality in the world economy has been exacerbating tension in international relations. For about four decades after World War II, the confrontation between the North (high-income developed economies) and the South (low-income developing economies) represented one of the two major axes for mapping international relations, together with the confrontation between the West (capitalist market economies) and the East (socialist centrally planned economies). Since the end of the cold war, the global confrontation between two superpowers in the East and the West has been replaced by multidimensional ethnic and local conflicts involving civil wars and terrorism. These relatively small but numerous and pervasive conflicts, if amplified by growing international economic disparity, will likely result in major instability in the world political system. Emancipation of people in developing countries from poverty is, therefore, not only desirable on humanitarian grounds but also necessary for developed countries whose peace and prosperity hinge critically on the sta-bility of the international order.
Scope of development economics
The major task of development economics is to explore the possibility of emancipation from poverty for developing economies. It should be strongly focused on low-income developing countries where poverty is especially acute. How can low-income economies in the world today be set on the track of sustained economic development for the immediate goal of reducing poverty and the long-run goal of catching up to the wealth of developed economies? The ultimate goal of development economics is to obtain an answer to this question.
Introduction 3
In order to achieve this goal, it is of course necessary to understand the structure and mechanism of low-income economies. However, the char-acteristics of low-income economies cannot be properly understood without comparisons with those of high-income economies. A key to identifying the causes of poverty and stagnation in low-income economies may be found in the experiences of economies that escaped from the same trap. It was through the process of economic development over a 200-year period since the Industrial Revolution that the majority of people in developed countries in the West were emancipated from poverty. The process was shortened to less than
100 years in Japan, and to less than forty years in Asian NIEs.
An effective theory of development economics should be based on understanding the similarities and differences of these histories compared with current situations in low-income economies. For this understanding it is vital to learn the theories of economic development by great economists in the past, who aimed to identify effective policies to promote and sustain devel-opment in their ages. Indeed, 'an inquiry into the nature and the causes of the wealth of nations' (Adam Smith, 1776) is equivalent to the inquiry into the causes of poverty and underdevelopment.
While it is critically important to learn from the experience of successful development, it is equally useful to learn from cases of failure. A dramatic example in our day was the recent collapse of centrally planned economies, which until only three decades ago had been considered by many to represent an effective model for developing economies to catch up and even surpass advanced market economies. Identifying the factors underlying both the failure of centrally planned economies as well as the relative stagnation of some developing economies that tried to adopt the central planning model, would be a vital step towards understanding the sustainable development mechanism.
It is relatively common to distinguish the term 'economic development' from 'economic growth,' though they are used interchangeably in some cases. 'Economic growth' has a connotation of quantitative expansions in economic variables, especially aggregate and per capita national incomes as measured by such statistics as GDP and GNI. Therefore, the analysis of economic growth is concerned mainly with measuring growth in economic variables and identifying their interrelationships such as between the national income growth rate and the speed of capital formation.
On the other hand, 'economic development' is usually conceived as a process involving not only quantitative expansions but also changes in non-quantitative factors such as institutions, organizations, and culture under which economies operate. If we follow this usage, economic growth is
considered a quantitative aspect of economic development. If so, in addition to the analysis of economic growth, the study of economic development must investigate the influences of institutional and cultural factors on economic growth as well as the impacts of economic growth on those factors.
Since this book is focused on the development of low-income economies towards catching up with high-income economies, the range of eco-nomic growth concerned is so wide that major cultural and social changes are necessarily involved. Thus, it is inevitable that this book is intended to be a treatise of economic development as its title suggests. To be effective, how-ever, development economics must incorporate the achievements of eco-nomic growth analysis to the maximum extent.
Among the many issues and subjects pertaining to development economics, this book is strongly focused on the role of technology borrowing as a major means for low-income economies to catch up with advanced ones. A critical condition for the transfer of foreign technology is development of appropriate institutions. For new institutions to function effectively, they must be con-sistent with people's value system in the recipient economy. Thus, a major agenda of this book is to investigate the potential of developing economies endowed with different social and cultural heritages to achieve institutional innovations needed for effective technology borrowing. The overall aim is to identify possible means to facilitate this process.
An equally strong focus is placed on the choice of economic system for development. In this book, this issue is posed as a question of what would be the optimum combination of market, state, and community. These three organ-izations coordinate the division of labour among people—the market by means of competition, the state by means of coercion, and the community by means of cooperation. They have both merits and demerits in coordinating people's economic activities in a socially desirable direction. How to combine market, state, and community in the economic system for maximizing growth in social productivity, under the unique cultural and institutional conditions in each economy will be the ultimate question addressed by our investigation.
While special focus is placed on low-income economies, the book covers broadly'developing economies' at various stages of development. However, no consensus exists on the definition of 'developing economies'. Until recently, a common practice was to classify as developing economies all countries other than OECD members, high-income oil exporters, and centrally planned eco-nomies in Eastern Europe and the Soviet Union, while it was customary to include the centrally planned economies in East Asia such as China and Vietnam in this category as well. Since the collapse of the socialist bloc, ex-socialist economies in Eastern Europe and Soviet Union are now also often
Introduction 5
classified as developing economies. For more specific analyses, the United Nations' classification of 'low-income economies' (with per capita GNI less than US$ 745), 'lower-middle-income economies' (with per capita GNI between US$ 745 and US$ 2,975), 'upper-middle-income economies' (with per capita GNI between US$ 2,975 and US$9,206) in 2001 will be used (World Development Indicators 2003).
On the other hand, 'high-income economies' (more than US$ 9,206) in the UN definition include not only OECD members but also high-income oil exporters (such as United Arab Emirates, Kuwait, and Brunei) and others (such as Hong Kong, Israel, and Singapore) in 2002. Yet, in this book the term 'high-income economies' is used to represent the countries that joined OECD before 1995 (except Greece, Turkey, and Mexico). Also it is used inter-changeably with 'developed economies' and 'advanced economies.'
Organization of the book
This book is organized in the following manner. Chapter 1 aims to establish a theoretical framework for the whole volume. As a basic framework, devel-opment of the social system is considered as a process of interactions between the economic subsystem and the cultural-institutional subsystem. The eco-nomic subsystem consists of activities combining ecoeco-nomic resources (labour, capital, and natural resources) through technology to produce goods and services useful for human living. These activities expand through accumu-lation of resources and progress in technology to result in economic growth. People's economic activities are coordinated and controlled by institutions (which here means the rules of society) and culture (which represents people's value system). As relative endowments of economic resources change—for example when natural resources like land become scarcer relative to labour owing to population growth—new agricultural technology may be required to save land relative to labour. For this technology to be developed and adopted, a new set of institutions may become necessary. A model is developed to conceptualize how such technological and institutional changes are inter-related with each other, how they respond to changes in resource endow-ments, and how such responses are governed by cultural traditions.
Chapter 2 tries to develop a bird's-eye view on the current status and growth potential of developing economies by means of highly condensed international comparative statistics in order to postulate broad hypotheses for the analyses in the subsequent chapters. The development pattern thus drawn is far different from that of the growth stage theories a la Rostow (1966) in
which countries are supposed to advance linearly to higher developmental stages according to the order and sequence of their economic 'take-offs'. A dramatic contrast to Rostow's model is that per capita income in Argentina, which used to be one of the wealthiest nations in the period immediately after World War II, has recently been surpassed by that of Korea, which ranked among the poorest in the early post-war years. Similar examples are abundant if not quite so dramatic. It is evident that an apparent 'take-off does not guarantee sustained growth. It is also clear that wide differences in economic growth rates among developing countries are due not so much to differences in natural resource endowments, but may instead be explained mainly by investment in both physical and human capital. Data seem to support a hypothesis that the magnitude of such broadly defined capital formation does not depend very much on the level of per capita income. If so, it should be reasonable to hypothesize that even poverty-stricken economies can be set on the track of rapid economic development depending on the policies adopted. Chapters 3 and 4 analyse the effects of explosive population growth and resulting relative scarcity in natural resources in the low-income economies that are characterized by high dependency on the production and export of primary commodities. Chapter 3 tries to identify the causes of 'population explosion' in developing countries after World War II in the light of demo-graphic histories in both developed and developing economies in order to draw future predictions. Further, development theories by classical econo-mists such as Malthus and Ricardo who incorporated population as an endogenous variable in the economic system relative to fixed natural resources are examined to draw implications for developing economies today. Chapter 4 identifies the shift from resource-based to science-based agriculture as the basic force that prevented dismal predictions by Malthus and Ricardo from being realized. This chapter investigates the process in which the mechanism of science-based agriculture has now been transferred to devel-oping economies and how such process can be promoted and sustained. As concluded in the chapter, it is no longer possible today to sustain economic development through nineteenth-century-type natural resource exploitation, and any resource-rich economy is bound to stagnate in poverty without major efforts to improve natural resource conservation and utilization efficiencies. Chapters 5 and 6 examine the roles of capital accumulation and techno-logical progress in industrial development. Chapter 5 traces the major currents in development thought and ideology after World War II which have resulted in the adoption by many newly independent nations of a strategy geared towards maximizing capital accumulation in the industrial sector by means of government planning and command. This strategy tends to consider 'capital' synonymous with large-scale machinery and equipment embodying modern
Introduction 7
labour-saving technologies developed in advanced industrial countries. It thereby tends to overlook the importance of finding appropriate technologies for efficient use of scarce capital and abundant labour in developing eco-nomies. In more recent years, the basic defect of such strategy has become evident in the economic stagnation plaguing its faithful adherents. It has thus become recognized that accumulated capital cannot be an effective basis of economic development unless it is combined with appropriate technology and manpower under an appropriate organization. Chapter 6 examines insti-tutional conditions by which appropriate technology and human resources are developed for rapid industrialization. A conclusion is that government investment in scientific research and education as well as the organization of competitive markets to facilitate innovations by Schumpeterian entre-preneurs are necessary conditions for sustained industrial development.
Chapter 7 examines the problems of inequality, poverty, and environ-mental degradation that developing economies are facing. In the early phase of development, strong population pressure on limited land resources tends to push up land rent and pull down labour wage rates in the rural sector. In the urban sector the importation of labour-saving technologies from advanced countries tends to increase returns to capital relative to labour. Altogether, income disparity between asset-owning and assetless classes widens. Con-currently, as farmlands become short to support growing rural population, people tend to open and cultivate fragile lands in hills and mountains which would be better conserved for forest and pasture, with the result being serious soil erosion and flooding, and thus aggravating poverty in rural areas. In major cities air and water pollution tend to worsen at an accelerating pace because early industrialization often proceeds with little investment in pol-lution control. There is a real danger that the growing inequality and dete-riorating environment might create so much social tension as to result in major social disruptions. Yet, importation of social welfare institutions such as minimum-wage laws for the purpose of income transfer risks worsening the lot of the majority of poor people who stake out a living in informal sectors lying outside the realm of such programmes. A solution should be sought that is directed at counteracting the basic economic forces which create problems instead of trying to cure only their apparent symptoms.
Chapters 8 and 9 discuss what kind of institutional set-up would be appropriate for promoting economic development. In Chapter 8, this problem is considered from the question of how to combine the market and the state for the design of an economic system. In Chapter 9, the discussion is expanded to include the question of how to incorporate community relations into the economic system. The market is an organization coordinating competition among people seeking profits by impersonal means of prices. The state
intervenes in matters of resource allocations through the use of coercive po-wer. The community organizes collective actions based on mutual trust within a small group characterized by intensive personal interactions. Theoretically, the market is efficient in the supply of private goods. The community's com-parative advantage lies in the supply of 'local' public goods, of which the beneficiaries are locally confined, whereas the supply of 'global' or 'pure' public goods such as basic scientific research and judicial systems should be lie with the state. However, in developing economies where markets are poorly organized and characterized by highly imperfect information, they tend to fail to achieve efficient resource allocations even for private goods. Also, in some rural communities that had hitherto enjoyed free use of abundant natural resources under sparse population, it would be difficult to develop the ability to manage common-property resources at an adequate pace to cope with rapidly growing resource scarcity under accelerated population growth. In these cases it may appear necessary for the government to become involved in activities supplying private goods and local public goods. However, it must be recog-nized that in the economies where the market is undeveloped and local com-munities' resource-management capacity is low, the government's administrative and information-collecting capacity is also weak. Therefore, the expansion of the scope of government activities for the correction of market and community failures could well be subject to the high probability of gov-ernment failure, which could be much more costly to society.
What should be the right combination of community, market, and state for promoting economic growth is thus the problem of high research priority in development economics. There is no single optimum combination uniformly applicable to developing economies. Under different cultural and social tradi-tions, the efficiency of the market may be relatively higher in one economy, whereas the organizational ability of community is relatively stronger in another. In the former it would be effective to increase the role of the market, whereas in the latter it would be better to expand the role of community. For example, in the course of modernization in Japan, a rather unique form of economic organization has been created under a different cultural and social tradition from that in the West. On the basis of this unique institutional set-up, Japan was able to catch up with the economic power of Western Europe and North America, though it has been turning out to be a negative asset in the development stage after the completion of catching up. Chapter 10 concludes with the argument that if developing economies today are to catch up with developed economies, they must develop effective economic systems each suitable to their unique cultural and social traditions as well as their development strategies.
1. A Theoretical Framework for
Economic Development
In this book we will examine the economic development necessary to bridge the extremely wide gap in per capita income between the low-income developing economies and the high-income developed economies in the world today. Such extensive economic growth cannot be realized without examining the requisite major changes in social organizations and people's value systems. Understanding the process by which quantitative expansions in economic variables (such as capital and labour force) interact with culture and institutions to evolve a social system that supports major growth in per capita income should be the ultimate goal of development economics. As a step towards this goal, development of a theoretical framework for the analysis of complex relationships among economic, cultural, and institutional changes is presented in this chapter.
1.1 Development of the Social System 1.1.1 A model of dialectic social development
A broad conceptual framework for development of social systems is outlined in Figure 1.1. This figure illustrates a model of the evolution in social systems through dialectic interactions between economic and cultural-institutional variables. The lower section of this figure represents the economic sector as a subsystem of society. This subsystem consists of interactions between tech-nology and 'resources'—broadly defined as 'factors of production', including natural resources, labour, and capital. Technology is the determinant on the value of product to be produced from a given combination of production factors, commonly called 'production function' in economics.
If we measure economic growth by the increase in average per capita product (or income), it is realized through increases in per capita endowments of resources and/or 'progress in technology' defined as an increase in product for given inputs of resources. 'Product' is defined here as economic value newly added to society by the inputs of labour, capital, and natural resources within a period; this Value added' is distributed to owners of the resources to become their incomes, which are aggregated into the income of the society.
Increases in economic resources and progress in technology are not inde-pendent. For example, as the technology of controlling water-flows is
FIG. 1.1 Interrelated developments in the social system
developed and necessary investments are made for use of the technology-such as construction of irrigation canals and diversion dams—hitherto useless barren lands could be converted into economically useful arable lands. If more food could be produced on the increased land resources, the food sur-plus might be stored, allowing a greater portion of labour input to be diverted from food production to capital formation activities in the next period.
Thus, while the progress of technology provides a basis of resource aug-mentation, it is promoted by purposive resource-using activities. For exam-ple, advances in irrigation technology are achieved through research on the identification of water-flow patterns as well as the development of irrigation facilities for adequate control of the water-flows through experiments of various designs, be it done by scientists and engineers in modern research laboratories or by primitive trial and error by peasants on their farms. Those activities use both human effort and capital for the addition of the stock of engineering knowledge. Since this increase in knowledge has the same output-increasing effect as investment in tangible capital—such as the con-struction of irrigation canals and dams—research and development activities can be called 'investment in intangible capital'.
Framework for Economic Development 11
Similar to the production of tangible capital, it is possible to formulate a process of producing technical knowledge from the inputs of labour and capital. A critical element in augmenting this knowledge production function is 'investment in human capital', defined as enlargement of human capacity by such means as education, training, and health care. Investment in human capital will increase the efficiency of knowledge production, which in turn will improve the efficiency of production of economic value added from given resources in the society. Thus, cumulative increases in average product per capita will result from investments in both tangible and intangible capital.1
The productivity of an economic subsystem, consisting of its resource endowments and technology, is conditioned by culture and institutions in society. Broadly defined, institutions as well as technology are a part of culture. However, culture is here narrowly defined to imply the value system of people in the society, while institutions are defined as 'rules sanctioned by the members of the society' including both formally stipulated laws and informal conventions. Cultures and institutions thus defined are inseparably related. The rules that contradict the morals of people would not be sanc-tioned socially and, if stipulated formally, would not function effectively. For example, the institution of slavery to stipulate a person's property rights on other human beings could hardly be expected to function as a social insti-tution today as it is inconsistent with the culture of the modern world. Yet, it was a perfectly legitimate and effective institution under different cultures such as in ancient Greece and Rome.
Culture and institutions indicated in the upper section of Figure 1.1 as components of the social system exert significant influences on the eco-nomic subsystem located in the lower section. For instance, an important parameter to determine the rate of investment is the ratio of saving to income; this parameter is determined largely by people's future preference over present consumption, which is a part of their value system. It has been the tradition of modern neoclassical economics to analyse the workings of the economic subsystem under the assumption of fixed pre-ferences. Such an approach would be effective for the analysis of a situation in which the upper subsystem was relatively constant. Yet, the approach would be grossly inadequate for dealing with the wide range of economic development within which major cultural and institutional changes inevitably occur. In this respect, the theory of Max Weber (1920) identifying the Protestant ethic as a source of modern capitalist develop-ment represents an important methodological suggestion, irrespective of its empirical validity.
1.1.2 A historical example
While accumulation of resources and progress in technology are conditioned by culture institution changes in the latter are also induced by the former. Such a process of social development through dialectic interactions between the economic and the cultural-institutional subsystems may be understood more concretely by tracing the transition from the hunting and gathering economy to the agricultural (and pastoral) economy.
A basic force inducing this epochal change in human history was the increased scarcity of natural resources under the pressure of population growth.2 As long as population was sparse and land was felt to infinitely exist like air, the killing of wild animals and the harvesting of wild crops in unlimited amounts would have shown no sign of exhaustion. However, as population grew (though very gradually), it was inevitable that the day would come when exploitation of the wild resources began to exceed their repro-ductive capacity and, thereby, the hunting-gathering economy could not be sustained.
To avoid the subsistence crisis that arose from this resource exhaustion, it became imperative for hunters to augment/increase the reproduction process by raising animals instead of killing and eating them immediately, and for gatherers to plant nuts and cereals for future harvests. An economic basis of the increased reproduction was the accumulation of capital. A limited list of capital items was required for hunting and gathering, such as stones, knives, clubs, and bows and arrows. A larger capital stock was required for shifting to the agriculture-based system, especially in the forms of reared animals, stand-ing crops and trees, and opened and cultivable farmlands. Capital requirement increased further as the agricultural production system advanced to the stage at which it began to rely heavily on man-made land infrastructure, such as irrigation and drainage facilities.
To convert animals and plants to productive capital, it was necessary to accumulate knowledge to identify useful animals and plants for domestica-tion as well as the appropriate methods to feed and grow them. Countless efforts of primitive producers to advance agricultural technology through trial and error were the major source of investment in intangible capital. These efforts to enlarge the reproduction process under the growing scarcity of natural resources are likely to have been induced by the producers' need for survival.
While such advancement in technical knowledge was necessary, it was not sufficient for the development of the agriculture-based economic system. This development required a major institutional change: establishment of property
Framework for Economic Development 13
rights on productive resources. A basic rule in ideal primitive hunting and gathering economies was free access to natural resources, under which all the resources were the property of everyone but no one person's property in particular. Under this rule anyone could capture and consume any useful animals and plants as they found them. As long as this rule prevailed, a person who attempted to engage in agricultural production had to face the difficulty of preventing others from taking away the animals and crops he raised. In such circumstances there would have been little incentive for anyone to start agricultural production by investing in livestock and standing crops. There-fore, the requisite for the formation of an agricultural economy was the establishment of a new social order of clearly defined property rights by which the person who made efforts to invest in productive capital could exclude others from its use (Demsetz, 1967; Alchian and Demsetz, 1973). In the course of this development of agrarian civilization, property rights were first assigned to livestock and standing crops, and later extended to cover agricultural lands. Those who were assigned property rights on land would have been equipped with strong incentives to invest in improving the quality of the land, from removing stones and tree roots, fencing and terracing, to irrigation and drainage. The form of property rights also evolved from communal ownership by tribe or village to private ownership by household or individual, with a stronger power of exclusion and, hence, a stronger incentive for private investment.
Common to all institutions, stipulation and enforcement of property rights entail costs. The most profitable situation for an individual is for him to break the rules (e.g. steal others' properties) while others are observing the rules (e.g. do not steal others' properties). Thus, the temptation is always high for anyone to become a 'free-rider' who tries to gain from breaking the rules. To the extent that people's propensity to become free-riders is high, it is costly to enforce the property rights by such means as police and courts. It is the ethics as a part of culture that reduces the cost of enforcing the rules of society. Indeed, 'thou shall not steal' is a unanimous moral code in the commandments of the great religions that coincided with the development of agrarian civil-izations. It seems reasonable to hypothesize that such a religious doctrine was both the cause and the consequence of establishment of the agriculturally based economic system.
Economic and social development through such interactions between economic forces and cultural-institutional elements have been repeated over history. For instance, the patent system that was established with the development of modern industrial society was aimed at assigning property rights on engineering knowledge and information, thereby promoting private
investment in this critical component of intangible capital (Evenson and Westphal, 1995). Negotiations in the GATT (General Agreement on Tariffs and Trade) Uruguay Round followed up by WTO (World Trade Organization) on intellectual property rights represented an attempt to establish inter-nationally uniform rules on the protection and the transactions of property rights over a wide range of knowledge and information including computer software. This attempt was a response to the growing need of the world today in which the role of knowledge and information, as a factor of economic production, has been rising faster than that of tangible capital. Likewise, the establishment of the International Law of the Sea creating exclusive economic zones over 200 nautical miles from each country's coast was an attempt to mobilize conservation efforts for marine resources at the national level in response to growing scarcity and high prices of fish and other marine prod-ucts (Hannesson, 1991). These are among the efforts to achieve the institu-tional innovation of the same nature as developing property rights on livestock, crops, and lands in the prehistoric initiation of agriculture.
7.7.3 Marx and new institutionalism
The theoretical framework outlined above has a basic similarity with the perspective on evolution of the social system described by Karl Marx and Friedrich Engels.3 The economic subsystem and the cultural-institutional subsystem in Figure 1.1 correspond broadly with what they term 'infra-structure' and 'super'infra-structure', respectively. In their system, the core of the superstructure is the property-rights relations of production factors (so-called 'production relations'), while infrastructure is the technology needed to determine the capacity of material production from available resources. While the institution is believed to determine realization of the technology's pro-duction potential, technology is identified as the basic force in structuring the institution; at the origin the institution is so structured as to best exploit the potential of material production. This view on the formation of institu-tions in response to economic demand is analogous to the theory of induced institutional innovation.
Marx and Engels assumed a major time-lag between increases in material production capacity and changes in institutions; this made changes in the social system discontinuous and abrupt. In their perspective technical knowledge and tangible capital are accumulated gradually to bring about continuous growth in productive capacity. In contrast, institutions cannot adjust immediately—they must be stable over time so that the rules of society
Framework for Economic Development 15
for structuring people's stable expectations in dealing with others could effectively function.
Moreover, the core institution in the Marx-Engels theory is the property-right assignment of a key production factor at each stage of economic development—such as slaves in the ancient classical world, land in medieval feudalism, and capital in modern industrial capitalism. Changes are bound to take time as it will be strongly resisted by the prestige class to whom property ownership is exclusively bestowed. As a result, even though the institution was originally designed to best exploit the productive potential of society, as it becomes inconsistent with the changed conditions of material production resulting from technological progress and capital accumulation, it tends to survive. In other words, the institution that was once a carrier of economic development over time turns out to be the 'fetter' against further development under a new technology regime. Marx and Engels theorized that this gap between the institution and the production potential would be ultimately closed through a violent political revolution. This perspective was forcibly marshalled in a classic statement by Marx:
The mode of production of material life determines the general character of social, political and spiritual processes of life. At a certain stage of their development, the material forces of production in society come into conflict with the existing relations of production, or—what is but a legal expression for the same thing—with the property relations within which they had been at work before. From forms of development of the forces of production these relations turn into their fetters. Then comes the period of social revolution. With the change of the economic foundation the entire immense superstructure is more or less rapidly transformed. (Marx [1859], 1904: 11-12)
Marx considered technological progress and capital accumulation decisive in determining the productive capacity of society and denied the importance of natural resources relative to population. In this respect, our perspective differs from Marx's and is closer to that of new institutional historians in emphasizing the influence of changes in relative resource endowments and prices due to population growth and other factors (North and Thomas, 1973; North, 1981). We also consider that institutions are not quite as inflexible as to make violent revolution inevitable for major institutional changes. There is considerable historical evidence to support the hypothesis that the basic institutional framework, including property relations, changed through cumulative adjustments by such means as informal agreements and reinter-pretations of laws and codes (Davis and North, 1970).
However, there is no guarantee that such cumulative adjustments are sufficiently rapid and responsive to emerging social needs. The cost of
incremental change in one institution can be prohibitively high as this par-ticular institution is inseparably intertwined with others. Its change thereby demands a change in the total institutional framework that has been his-torically determined (see Section 1.2.4 on this historical path dependency). Due to fear of social sanctions, such as ostracism, against the deviation by individuals from established norms and conventions, even obviously ineffi-cient institutions like castes are often difficult to change (Akerlof, 1984). Because a future gain from an institutional reform is uncertain, and its distribution among various social groups is difficult to predict relative to the obvious loss to a specific group, opposition to reform tends to be strongly organized, while support is only weakly so (Fernandez and Rodrik, 1991), in terms of the logic of the political market (Section 1.2.3). It is therefore not uncommon to observe that a society continues to be trapped in economic stagnation and poverty under a dysfunctional system bound by strong social inertia for the preservation of established institutions (Basu et al, 1987).
Thus, it is likely that changes in institutions and, more so, in culture lag significantly behind changes in the material production base, and that the resulting contradictions could often create strong social and political tension, culminating in major disruptions, as Marx and Engels envisioned.
1.2 The Theory of Induced Innovation*
The theoretical framework developed in the previous section is general but not very operational for economic analysis in the sense that the implied hypotheses are too broad for empirical testing. In the following section we will construct an operational economic model by extracting some elements from the general model, on which development economics must focus. For this purpose it is necessary to use technical terms specific to economics.
7.2.7 Induced technological innovation
First, our focus will be placed on a causal relationship within the economic subsystem in Figure 1.1, in which changes in resource endowments induce changes in technology. A standard economic theory on this relationship is called the theory of 'induced technological innovation' in the tradition of John R. Hicks (1932).
The Hicksian theory presupposes a mechanism in which, as the endowment of one factor (e.g. capital) becomes more abundant relative to another factor
Framework for Economic Development 17
(e.g. labour), a change in technology is induced towards using more capital and saving labour for given relative factor prices (for a more exact definition, see Appendix A.2). Such a biased change in technology stems from the efforts of profit-seeking entrepreneurs to reduce production costs by substituting relatively more abundant (hence cheaper) resources for scarcer (hence dearer) resources. The induced innovation theory within the framework of neoclassical economics has assumed a competitive market by which relative abundance and scarcity of factors are reflected in factor prices used as data for entrepreneurs' production plans. However, this theory can be applicable to subsistence-orientated non-market economies also, if it is assumed that relative resource scarcities are recognized by producers, even very roughly, in terms of shadow prices reflecting the social opportunity costs of the resources. Based on such assumptions, Figure 1.1 is a model explaining the process of transition from the hunting-gathering economy to the agricultural economy, as well as subsequent advances in the technology of agricultural production. With some modification, this model can be used to explain a transition to the industrial economy also.
Figure 1.2 represents the production relation (production function) of producing a single commodity (e.g. food) from inputs of three factors: labour (I), capital (K), and land (A) representing natural resources. Capital is here assumed to be produced mainly by past labour input.
The upper A-L quadrant in Figure 1.2 represents the substitution between land and labour in terms of isoquant for producing one unit of product (unit isoquant). On the other hand, the 0-Z line in the lower L-K quadrant represents the complementary relationship of capital with labour in the event of substituting labour for land. For example, as long as a farmer engages in slash-and-burn shifting cultivation, he can cultivate a large area using his own labour with very little capital consisting of such small items as a hatchet, a digging stick, and a stock of seeds. However, if he attempts to shift to a more labour-intensive, land-saving system under settled agriculture, he must build up large capital by improving farmlands (removing roots and stones, terrac-ing and fencterrac-ing) and acquirterrac-ing a greater variety of farmterrac-ing tools and implements than those needed for shifting agriculture. Thus, the substitution of labour for land through such intensification of land-use should be accompanied by exponential growth in the capital-labour (K/L) ratio. To illustrate this relationship, the 0-Z line is drawn in a concave form.
The /-curve in the A-L quadrant represents the 'innovation possibility curve', defined as an envelope of unit isoquants corresponding to all the possible technologies that could have been developed with the knowledge and human capacity available at a particular period. This curve shifts over time
FIG. 1.2 A model of induced innovation
(from 70 in period 0 to /j in period 1 as indicated in Figure 1.2) corresponding to the accumulation of knowledge and the improvement in human capacity. According to the theory of induced technological innovation, a particular technology as represented by i0 is developed and adopted for period 0, because it is this technology that minimizes the cost of production for the price ratio between land and labour (Po)» reflecting relative scarcities of these factors in this period. In other words, i0 is developed through the effort of producers to reach the cost-minimizing point a within an available set of possibilities (/0).
Assuming complementarity between labour and capital in their substitu-tion for land, as explained earlier, the land-labour ratio at point a(OA0/OI0)
Framework for Economic Development 19
corresponds with the capital-labour ratio at point d(OKo/OLo). Since in this particular case it is assumed that capital is the product of past labour alone, the price of capital relative to the price of land can be considered to move largely parallel with the labour-land price ratio (P0). This assumption of complementarity between labour and capital is adopted for the sake of sim-plicity to represent the three-dimensional relation in a two-dimensional diagram. This simplification might be permissible as an approximation to facilitate understanding the characteristics of technological progress in pre-industrial economies. For the analysis of pre-industrial economies in Chapter 6, the substitution between labour and capital as well as the substitution between tangible and intangible capital will be treated as a central problem. Assume that, as time passed from period 0 to period 1, relative scarcity of land increased with the result of lowering the relative price of labour to land from P0 to PI . Meanwhile, the innovation possibility curve would have shifted towards the origin from 70 to /], reflecting the increased capacity of society to produce a unit of food with a smaller input of factors. Corresponding to these changes, it now becomes optimum for producers to reach point c by choosing a technology represented by ii, over other possibilities embraced by /].
However, until the new ii technology is actually developed, producers will have to continue using the old i0 technology and, hence, can move only from
point a to b. It is through producers' efforts in repeated trial and error, as well as organized scientific research and development (in the case of modern society), that the new ii technology will become available. The basic premiss in the theory of induced technological innovation is that the expected gain (or reduction in cost) for producers, as measured by the distance between PI and PI, in the move from point b to c, will induce them to make efforts for technological development with the result of changing technology from i0
towards i\.
The move from hunting and gathering to agriculture may be explained in terms of this theory as follows: When the availability of usable land appeared to be limitless relative to sparse population and, therefore, the relative scarcity of land to labour (P0) was very low, collection of foods from wild animals and plants (IQ) could well have been an optimum technology in the sense that it produced food at a minimum cost. Even if population grew, and the relative scarcity of land rose (P0 to PI), there would have been little scope to increase
food supply by applying more labour to limited land (a to b) as long as hunting and gathering were the sole option for food production. However, if farming technology (ij) became available, people would be able to produce much more food from given land resources (b to c) at a lower cost. This possibility would have worked as a driving force for primitive hunters and
